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Cap Rates Compress Further In Tier II Cities

CBRE just came out with their Cap Rate Review for the first half of 2019. The numbers show that cap rates are continuing to compress across most multifamily markets in Tier II cities. The cap rate is the Net Operating Income (Rental and Other Revenue minus Expenses, but not including debt service) divided by the purchase price. As multifamily assets get more expensive, multifamily investors are getting more wary. However, this data doesn't tell the entire story. Investors who only look at cap rates are missing a key part of the picture. The 10-Year Treasury Rate, a proxy for lending rates, has decreased by 50 basis points. This means the spread between cap rates and lending rates may actually have increased in certain markets. And that's a good sign. Additionally, multifamily assets are experiencing high demand due to fewer single family housing starts in 2019. Harvard released a study recently showing that in many markets, thousands of affordable housing units have either vanished or shifted to higher cost units. Choosing the right debt product is more important than ever in multifamily deal structure. Existing projects should continue to perform well and certain projects acquired 2-3 years ago may present options for debt restructuring and liquidity for investors. Compressed Cap rates do mean that some will overpay for these assets, especially if rent projections over the hold period are too aggressive.